What is the 'Network Effect'

The network effect is a phenomenon wherein increased numbers of people or participants improve the value of a good or service. The internet is such an example. Initially, there were few users of the internet. It was of relatively little value to anyone outside of the military and a few research scientists. As more users gained access to the internet, they produced more content, information and services. More and more websites were also developed and more users connected to communicate with each other. These developments made the internet increasingly valuable to its users.

BREAKING DOWN 'Network Effect'

The rise of social media can be directly correlated to the network effect. The more users present on Twitter sharing comments, links and media, the more useful the platform became to the public. Similar growth through the network effect was seen with Facebook, YouTube and Instagram. The escalation of users on those platforms fostered more interest from even more users. Corporations have also sought to participate with these platforms to engage in the expanding conversations among the many consumers who interact online.

What the Network Effect Means to Businesses

A variety of services-for-hire apps and websites also benefit from the network effect. As more professionals list online they are available as dog walkers, tutors, or even electricians, even more customers begin to rely on such directories. E-commerce sites such as Etsy and eBay grew in popularity as more sellers joined those marketplaces and sold their products to the influx of consumers who embraced shopping online.

Ridesharing services also evolved and grew through the support of more participants signing up and expanding their reach across cities and states. As more drivers became part of Uber and Lyft, those brands gained in market value with passengers seeking rides.

The chief hurdle for any good or service that uses the network effect is to get enough users initially so that the network effects take hold. The amount of users required for significant network effects is often referred to as critical mass. After critical mass is attained, the good or service should be able to attract many new users because its network offers utility.

If too many people use a good or service, negative network effects such as congestion can occur. In the internet example, having too many users on the same network service can hypothetically cause the speed to deteriorate, decreasing utility for users. Providers of goods and services that use a network effect must ensure that capacity can be increased sufficiently to accommodate all users.

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